International Flavors & Fragrances Inc (IFF) 2005 Q1 法說會逐字稿

Good day and welcome to the first-quarter International Flavors & Fragrances first-quarter 2005 earnings release conference. Today's call is being recorded. The speakers for today's call will be Mr. Richard Goldstein, Chairman and Chief Executive Officer, and Mr. Douglas Wetmore, Senior Vice President and Chief Financial Officer. Gentlemen, please go ahead.

Thank you, good morning. Thank you for joining IFF's quarterly earnings conference call. Before we begin, I need to make some cautionary remarks. This call may contain statements that are considered forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and the current economic environment. Forward-looking statements and the projections are inherently subject to significant economic, competitive and other uncertainties and contingencies, that are beyond the control of management. The company cautions that these statements are not guarantees of future performance.

Actual results may differ materially from those expressed or implied in the forward-looking statements. Important assumptions and other important factors that could cause actual results to differ materially from any forward-looking statements and projections are specified in the company's 10 K filed with the SEC, and IFF's other filings made with the SEC from time to time. IFF does not update forward-looking statements and expressly disclaims any obligation to do so.

All right. For those of you who are regular participants in our earnings call, I want to point out that based on feedback we received from a number of you, we are streamlining the content and format of our conference call. We know that you receive or otherwise have access through the internet to our press releases.

Over the last several quarters, we have substantially expanded the amount of information included in the press release and to a certain extent have repeated the same information during the course of our past calls. Accordingly, instead of repeating the detailed results by region and category as included in our release, we believe it's more helpful to you, to focus our discussion on the actions and initiatives underway to drive long-term profitable growth at IFF. We will talk about the milestones we are reaching with respect to our corporate strategy and we will provide updates on the technological innovation that is so critical to our and our customers' ongoing success.

Doug Wetmore, our Chief Financial Officer, will continue to review our financial performance, it will just be at a higher level. Of course, we will also continue to have a Q & A session. Now that the new format for the call has been explained, let me turn it over to Doug, who will give an executive summary of our first-quarter financial performance and achievements. Doug.

Thank you, Dick. Good morning, everyone. Our first-quarter 2005 sales were $523 million, increasing two percent in comparison to the prior year. For this and subsequent comparisons I'll make, the comparable 2004 results exclude our European fruit business, which we sold in the second half of 2004. Relevant details regarding fruit are included in our press release. Our sales performance was led by a four percent increase in fragrance sales while sales of flavors increased one percent.

Reported sales for the quarter benefited from the strengthening of various currencies in relation to the U.S. dollar, notably the Euro. On a local currency basis, fragrant sales grew one percent while flavor signs declined one percent. Flavor sales most notably in North America and Europe were also unfavorably impacted by lower selling prices across the industry for naturals, mainly vanilla, the cost of which has fluctuated significantly over the last 24 months. Selling prices for such natural products generally move in line with the cost of the underlying raw materials.

Fragrant sales were led by fine fragrance, which increased 12 percent in dollars and nine percent in local currency. The fine fragrance performance reflected the benefit of a number of new-product wins, and we continue to win a substantial share of new fine fragrance launches. Sales growth by region by flavors and fragrances, as Dick mentioned, is detailed in our press release. For the quarter, our sales performance was strongest in India, Latin America, and Asia-Pacific.

Our 2005 growth in these regions is particularly impressive, given the very strong performance we achieved in each region in 2004. We continue to see a lot of opportunity in these markets and are strongly committed to them. You can expect us to continue to invest and build upon our leadership positions in these regions.

Net income for the quarter decreased seven percent in comparison to the prior year. The decline in net income was partially due to the elimination of the European fruit business. Our 2004 results included net income of $2.2 million attributable to this business. Proceeds on the sale were used to reduce debt, but lost operating profit was not replaced by interest expense savings.

In addition, gross profit as a percentage of sales was 41percent compared to 42.7 percent in the prior-year quarter. The gross margin performance was mainly attributable to increased raw-material costs and customer resistance to price increases. Our gross margin was also impacted by lower expense absorption attributable to the facility closure in Dijon, and the costs incurred in connection with the transfer of related production to other manufacturing locations. Production at the Dijon facility ceased in March, and such duplicate expenses will not recur in subsequent quarters. Declining selling prices for naturals, as I noted previously, also contributed to the margin performance. Now with respect to material cost increases, the cost increases have been in a fairly broad population of raw materials.

In addition, our costs for containers and packaging and freight, all of which are included in our cost of sales, have been impacted by the high cost of petroleum and related derivatives. The overall degree of increases in our raw-material costs are proving higher than had been previously anticipated. Moreover, we've not yet been able to fully pass on the impact of these cost increases to our customers. Notwithstanding, the cost increases we continue with our many research and development efforts, our R&D expense totalled 8.6 percent of sales compared to 8.3 percent in the prior year. And this is consistent with our intended level of R&D spending.

Sales in general in the administrative expenses as a percentage decreased to 16.2 percent from 16.8 in the prior-year quarter. Our SG&A expenses include about $2.5 million of equity compensation expense for which there was no comparable expense included in the 2004 first-quarter results. However, this added expense was offset mainly by lower year-over-year accruals, under the company's various incentive compensation plans. Our earnings per share for the quarter were $0.55 cents compared to $0.59 cents or the prior-year quarter.

Our capital spending remains on plan for the full year 2005. We currently expect to spend $90 to $100 million for the full year, if we spent about $16 million in the first quarter, but that pace of spending will increase as the year progresses. And during the first quarter, we repurchased approximately 725,000 treasury shares under existing buyback programs at a total cost of around $30 million. At March 31, 2005, we had a remaining authorization of about 46 million under our latest share-repurchase authorization. Now Dick will discuss some of our strategic and operational highlights for the quarter, Dick.

Thanks, Doug. The actions we have taken to refocus on our customers, and our heritage of innovation, are creating positive momentum. This is demonstrated in IFF's improved win rate and sales trends, most notably in India, Asia, Latin America, as well as in parts of Europe. These are exciting regions filled with opportunity and we are committed to capturing the long-term growth prospects there. It is clear that our customers have confidence in IFF, our people, and our products.

This is setting us apart from the competition and bodes well for our future. To support our growth in sustained success, we continue to make targeted investments. Construction of our new state-of-the-art chemical facility in China is on schedule for completion in commissioning in the second half of 2006. And we will be opening our new fragrance creative center in India later this year. These two facilities, along with other strategic investments being made elsewhere, will allow us to fulfill the needs of our global, regional, and local customers.

At the same time we invest in infrastructure, we also continue to focus on customer service and, most importantly, research and development. For example, newly created molecules and natural extracts will contribute to flavors and fragrance wins in 2005 and beyond. In 2004, we filed 28 patent applications, accelerating the pace of the development we have been striving for. We are currently working with major customers to advance the commercialization of these new and exciting technologies.

Currently, we have a number of new products employing our proprietary encapsulation technology in market tests with major customers in various regions. Early indications are that there are clearly discernible consumer preferences for the products containing our technology. If all goes well, some of these products could be launched as early as the second half of 2005, with the pace expected to accelerate in 2006. But as I have said before, please remember that our customers establish the time frames for the launch of these products. We follow the path to market established by our customers.

Our delivery in material technology research also continues to advance other commercial applications of flavor and fragrance encapsulation technology. With ongoing innovation, we can extend our encapsulation technology to include, for instance, aroma transfer of technology and packaging application. It's this kind of innovation that makes our company unique, and helps our customers create winning products. In terms of customer service, we continue to build on our success.

Integral to continued improvement in this respect is the completion of our SAP implementation. I am pleased to report that we recently had a successful launch of SAP in Indonesia, and we are on track to essentially complete the SAP implementation across the company, later this year. SAP is an invaluable tool to better service our customers, better manage our resources and information, so that we can better manage our business. We are already realizing enormous benefits from SAP, and such benefits will only grow in the years ahead. We are unwavering in our strategy of being customer focused and technology driven. Our primary objective is to provide our customers with technology and innovation, products and service, that will help them win in the marketplace.

Looking to the balance of the year from a financial point of view, we are updating our earnings expectation. We remain on track with expectations for our topline growth. We continue to expect 2005 revenues to grow in local currency in the low-to-mid single digits. Based on current exchange rates, we expect this will result in a sales in crease in reported dollars in mid-single digits. As we have discussed in the past, these growth expectations exclude the impact of $58 million worth of fruit sales from the 2004 comparative. However, as we noted in our press release issued earlier today, gross margins are expected to remain under pressure for the balance of this year.

This pressure is the result of increased supply-chain costs exceeding those previously forecast. Our expectation is that fully implementing price increases to restore our margin will take the balance of this year. Accordingly, we now expect earnings per share for 2005 to be in the range of $2.20 to $2.35 compared to $2.05 reported in 2004. Before we open the call to questions, it bears emphasizing that during the quarter we achieved a number of new wins, and continue to see strong sales trends in many of the markets we have targeted for growth.

However, we, like others in our industry, continue to face challenges brought on by increased raw-material costs and resistance to price increases. By remaining focused on innovation, superior service, and operating discipline, I am confident that we can continue to differentiate ourselves from our competitors and drive market-share gains to create value for our shareholders. Thanks, and we will now open the conference to questions.

Thank you., gentlemen. [OPERATOR INSTRUCTIONS] We'll take our first question from Jeff Zekauskas of J.P. Morgan.

Good morning, this is Silka [inaudible] for Jeff, how are you?

Good morning Silka.

Hello Silka.

A couple of questions. Your local currency growth performance excluding the fruit business was mainly pressured in North America and growth in the offshore regions India and Latin America seemed still very healthy and that is somewhat -- that is somewhat different from what your competitors reported, so overall do you think that you gained some share particularly in the flavor business overall?

Yes, Silka, I believe that we are in fact gaining share, not only in fine fragrance, and that trend began last year and continues well into this year, but we are finding that we are, I believe, taking share in the other regions in the flavors category and also in fine fragrance as well.

Secondly. If you exclude the fruit business, do you expect -- I guess like two percent to five percent local currency growth in 2005? And in the first quarter your volume performance was zero, and there's still difficult comparisons coming up. Can you just discuss where the local currency growth is coming from?

It -- you know, Silka, you're absolutely right. We have a particularly difficult comparison, most notably in North America, in the first half of the year, but let me give you some updated guidance for each of the geographic regions, and this is updated from the guidance we provided at the time of our January call. North America fragrances are expected to increase in the low single digits and driving that we expect to see some improvement in our fine fragrance sales over that which is achieved in the first quarter.

In that regard, please remember fine fragrance has a very difficult comparison with the first quarter of '04. North America flavors are going to be flattish in comparison to 2004. They have a very difficult comparison. That's down slightly from what we expected previously and one of the key elements driving that is vanilla pricing.

Europe fragrances will increase in the low -to-mid single digits in local currency, resulting in a mid-to-high single digit increase in reported dollars based on current prevailing exchange rates. Growth in Europe fragrance is going to be driven by continued strong performance, in fine fragrances, and a little bit of strengthening in functional fragrance as the year progresses. The Europe flavors are expected to increase in the low single digits and local currency terms, which will result in an increase in mid single digits in dollars. And those expectations exclude the sales attributable to the fruit business from the 2004 comparative.

Latin America fragrances will increase in the low single digits, reflecting good wins and fairly stable economic conditions throughout much of the region. Latin America flavors are expected to increase in the high single to low double digits, reflecting increased wins. That's a strengthening in expected growth for '05 compared to previous expectations.

Asia-Pacific fragrances are expected to increase in the low single digits in local currency, resulting in a mid single digit increase in dollars while flavors in Asia are expected to increase in the mid single digits in local currency, resulting in a high single digit increase in dollars. And India fragrances and flavors are expected to increase in the low double digits in both local currency and dollars, and that's continuing the pattern of strong growth we've achieved there over the last several years. And overall on a consolidated basis, we expect to have fairly consistent growth in both flavors and fragrances. Both are expected to increase in the low-to-mid single digits in local currency, resulting in that mid single digit increase in reported dollars.

Okay. So that means that it seems that a lot of the improvement will come from -- will come from flavor sales in India and both in Latin America, like those seem like a -- these provisions seem to have improved.

Yes and I think Asia improved a little bit, most significantly, in flavors. But there -- those are probably the areas where some of the resistance that -- you use a more limited pallet of materials where you may not have quite the level of cost of material increases. There's a number of factors at work. But , certainly the developing areas of the world are driving our growth expectations this year, and that's really consistent with our long-term strategy.

All of that, Silka, you recall, is -- where we expected on an ongoing basis to be able to get a disproportionate amount of growth for the reasons we've discussed on numerous calls.

Yes, and maybe last question then I'll get back in queue. I don't remember IFF really ever discussing in detail raw-material cost pressures, so I was wondering whether you can kind of like discuss what the magnitude of the cost pressures of the raw-material cost pressures really are? And -- and, also, I do not really remember you speaking about selling price increases lagging. So is there any indication that new business wins are slowing, or can you just put a little bit more color on that.

I mean, I -- first of all, picking up on your last point. It has nothing to do with the -- with new business lagging at all. It's -- we're in the supply chain and we're in a mode today that we haven't seen in the past in the -- what I call the more-recent past. For many years, we were talking about no inflation and indeed deflationary times. We now are seeing that we are really seeing -- we are in inflationary times and we're seeing it most dramatically in petrol chemical-based pricing.

And as we are experiencing greater price increases from our suppliers, particularly in the petro-chemical-based product ranges, containers, packaging, and raw materials, we are moving as rapidly as we can to recover the price increases, but there is a lag in the system. And we're desperately pushing forward to close that gap, but in -- we do not believe that we are going to be able to do it immediately,but we do expect that we will be able to increase and restore our margins, but it will take the balance of the year to do so.

I would like to add to that, Silka, and then to touch -- I'll give you a little more detail on some of our raw-material cost increases. Every time we win a new business, that's the opportunity for us to have, in essence, a price increase because we're creating with the way this cost of raw materials, but remember, that represents, on average, over a sustained number of years, probably about 10 percent of our sales in any given year. But the balance of the portfolio, which is the good news and bad news, we have a very long-standing -- or a sizeable portfolio of continued business, there is -- that's the -- where we're experiencing the lag in terms of being able to pass on some of our cost increases to our customers in the form of price increases.

To give you some example, in the first quarter this year our raw-material costs have overall -- and mind you there have been some declines, but generally the overall raw-material portfolio has probably increased in the range of five percent to six percent for raw materials. And in addition to that, as I guess basically with every other company that ships goods, they've seen a marked increase in the cost of freight, as I mentioned that's an element of our cost of sales, and also containers and packaging, which in our case has increased almost in excess of 20 percent. Our containers and packaging are generally steel drums and plastic containers.

Steel is being driven up, as everyone well knows, by continued demand, most notably in China, but also on a global basis. And the plastic costs are going up because they are a derivative of -- they're a by-product of the petroleum industry. So those are key drivers, as Dick mentioned earlier, petroleum costs are one of the key factors that's driving up our costs. And we are working to manage those costs as tightly as we can, but at the same point in time, we are working to pass on those costs as best we can to our customers. And, as we said, we have experienced some resistance in achieving that.

Thanks very much.

Our next question is from Todd Peters of American Century Investments.

Hello, good morning.

Good morning, Todd.

Hello Todd.

A quick clarification on your past -- your comment on your costs. The overall raw-material of five percent to six percent, is that a year-over-year number?

Yes.

Okay.

Yes.

Then my question I wanted to ask you on your capital spending of the F$90 to $100 million, and is there any additional SAP cost embedded in there, and can you just tell me exactly what that $90 million is doing for you this year?

Well, it's -- the $90 million is investing in the future. I think the two major undertakings are those that Dick mentioned, the new aroma chemical facility in China, as well as the new creative center in [inaudible]. And I don't think anyone would debate the merits of sizeable investments in either China or India, given our growth in each of those areas.

In terms of SAP spending, we will continue to have about a million dollars a quarter, somewhat more, somewhat less in the quarters, for true expense, and that's related to training and data conversion. And those will pretty much tail off at the end of this year as we complete the SAP implementation.

In terms of capital spending, there is very little remaining associated with SAP, other than a need to upgrade personal computers and so forth in those locations that are about to implement. SAP is not at this stage a big driver of our capital spending.

Okay, and then what do you estimate your capital spending to be, lower in '06 estimate?

In -- you know, it is -- this year is somewhat higher than the past couple of years, and the reason for that, as we mentioned in the January call, was that some '04 spending actually crept into '05 simply because of the timing of initiation of projects. But we said in the January call that over the three-year period, '05, '06, '07, we would probably spend in the neighborhood of $225 to $230 million cumulative.

And obviously depending on exchange rates, since a lot of our spending is outside the United States. And that's basically -- say on average, $75 million a year. And based on current expected depreciation expense, that's at a level just slightly below what our annual depreciation would be.

Right, so your depreciation last year was 91 million, do you see that moving up a little bit this year again?

No, I think you may be including amortization of identified intangibles, which was about $13 or 14 million, so our depreciation was about 76 or 77.

And that should stay steady? -

Yes, and as I say, though, it does fluctuate because of exchange rates because a lot of our plants and so forth are outside the United States.

Okay, very good. Thank you.

Thank you.

We go now to George Nissan of Merrill Lynch.

Thank you very much. A couple of questions. What I noticed in the last couple of months, a lot of your competitors have recently been implementing some new strategic initiatives for technology to help them reduce their raw materials and sourcing costs with their suppliers, and also to establish a better line of communication with those suppliers and collaboration.

I'm interested if you could provide some color as to what are you guys doing, what are some new strategic initiatives you can enlighten us on, that your implementing to reduce those sourcing costs to your suppliers and enable some better communication collaboration in regards to supplier score carding, run better support scenarios, etc., to help you guys reduce those raw-material costs and packaging costs that you expressed so much concern about.

George, could you clarify? Who amongst our competitors is undertaking some of those initiatives?

Well, there's several competitors right now.

Could you name one or two of them? Because I have not really seen anyone that has come out and specifically commented on that type of initiative. Not -- I'm not arguing with the merits of it.

I know there are quite a few, I would like to keep those for right now. I am just curious as to what you guys are doing?

Well, we have always -- IFF has a legacy of, one, being very cost conscience and, two, being very focused on buying intelligently in the industry. We're one of the largest players. I think we have the opportunity to exert influence on our suppliers, to the extent that we are a significant player in the market, but you also have to understand that, unlike some of the companies that you may be thinking of, we buy a lot of natural products and agricultural products that fluctuate, depending on supply and demand, and they are being driven up right now in many cases. So -- and as we mentioned, SAP is one of the key tools that we have been using since 1999 to manage our business and to understand our raw materials and better do material requirements planning. So we are going to continue to keep doing the things that we do. I am not quite sure what more enlightenment I can provide to you.

I can only add to that, that we have strategic relationships with -- with all of our major suppliers, and have for a number of years, and worked with them in terms of looking for and finding alternatives when we can substitute them for raw materials that may have unusual spiking, but we are not in a position to do that with respect to naturals, because those naturals are particularly important as raw materials for our customers.

And just an added point, I think on our linkage with our customers, I think I am quite confident that I can say that nobody has better systems and support in our industry to link with our customers in terms of information technology, and SAP is just one of the many aspects of that. So I think we are at -- nobody is better than us in the industry in that regard.

Okay, thank you.

We go now to Richard O'Reilly of Standards and Poors.

Good morning, gentlemen.

Good morning, Rich.

Hello Rich.

A couple of follow-ups on the raw material pricing. First one is quick on raw materials. What is your split of raw materials between man-made and natural products, inputs, if you understand what I am trying to drive at?

Well, I understand what you are trying to drive at. It is -- you know, we buy about 7,000 different raw materials a year, Rich. It is -- I can not provide you the precise breakdown. I am really not inclined to provide you the precise breakdown, but there are substantial elements that are natural and agricultural. And we do purchase things like petrochemical by-products, which serve as feedstock for some of our chemical operations. We also purchase turpentine derivatives. How do you characterize something like that? Because they are naturally occurring but they tend to be by-products of other industrial processes.

Okay, all right. Your selling prices; how do you -- is it quarterly, is it as annual contracts come up? I mean, what's the process of you trying to get price increases through, besides beating your customers over the head .

Studies show that does not work well.

It varies, Rich. I mean, we had -- there is no universal model with respect to establishing prices with our customers. It varies by customer and it also varies in terms of timing during the course of the year when those discussions would take place, depending upon customers' fiscal years and depending upon just the cycling for renewing our relationships on pricing with them. But there is -- there is a -- a chain, if you will -- or a supply chain that is involved starting back from where we are sourcing our materials and back from where the -- our suppliers are also sourcing their materials, and there is an add-on effect. And in the petrochemical area in particular, the rate of increase has outpaced, I believe, virtually anybody's expectations this year. And that is the principal reason for the -- for the margin compression at this juncture.

Okay. Would you have -- would some of your contracts have cost pass-throughs, or is that just not done in your industry?

That's -- a very good example of that is the Vanilla, which I mentioned in our opening remarks, where the selling prices do fluctuate based on the underlying cost of the raw materials. That, to the extent that the -- the vanilla is sold as an extract. To the extent that vanilla is sold as a component of a flavor -- or fragrance compound, because vanilla is used in both, then it is just an element of driving the overall cost of that compound. However, it is -- we have seen -- and I think this is pretty well documented in a -- throughout the financial world, is that there is a surging amount of cost increases across a broad portfolio of raw materials. And it's driven by demand. In some cases, those increases are aggravated by perhaps a weakening of supply. Another example I can give you is grapefruit oil.

Because of the hurricanes in Florida last year, citrus was going to be affected. However, it is proven to only be grapefruit that's been significantly impacted. Why? Brazil had bumper crops of orange and lemon, which basically served to offset the impact of the Florida shortages of orange and lemon. However, there was no offset for grapefruit. So you see an impact of grapefruit. And grapefruit is used in both flavors and fragrances. So it -- I can give you anecdotal examples, Rich, but -- I -- take a long time to cover 7,000 raw materials.

No, you generally -- I just -- I feel I am confused on the calls -- we have never talked about raw materials. I am a chemical industry analyst.

I think the key thing with this -- and it predates even my being at IFF, is the last time you saw a surge like this in overall raw-material costs was in the early to mid'70s, but it was also associated to a certain extent with petroleum. Because at that point in time, petroleum surged greatly again. In fact, more so percentage-wise than it has done recently.

All right, good. Thanks a lot, guys.

I'm not that old, though.

Our next question is from Chip Ruy of Cramer Rosenthal.

Hello guys.

Hello, Chip. [Inaudible sounds]

I want to speak a little bit more to the price increase because we've talked a little bit in the past about how your goods sold, are just a small fraction of the end product to your customers.

Right.

So a small price increase that you're after -- you know, five percent or so, is almost meaningless. And to your point, Doug, everybody knows steel and oil is up. So can you just characterize your discussions? Are you -- were your salespeople not asking for price increases and now they will? Have you been getting pushback from your customers? Because, it seems -- if somebody has a formulation that uses one of your ingredients, they are not going to change formulation, which you have said in the past. So it seems to me, you will be able to get some price increases pretty quickly and maybe it will be 90 to 100 days, not 200 days at the end of the year.

Rich, if I know -- Dick wants to make a comment, but do not think that we have not obtained price increases. So what we have said, is the pace of increases in our raw-material costs, aggravated by a couple of the other elements that we talked about, like the Dijon closure, which is a duplicated expense, have driven our margins down. And, as Dick said in his comments, we expect to fully implement the price increases. It is going to take the balance of this year.

It would be wrong -- it would be wrong to make the assumption that we have not obtained any -- any pass-throughs. But the pace at which they have occurred -- and I do not think that you -- need to just look at our experience, but just what you are hearing from others in the industry, and I do not mean our industry, but others out there as well, is the pace of the -- and the continued increase is in excess all-- what any of the reasonable expectations would have been in our most early discussions with our customers, which causes us now to need to revert and have further discussions in order to be able to recover the margins on the basis of, as we have said repeatedly in this call, the petrochemical-based products, containers, packaging, and various raw materials.

But, please, do not make the assumption that we have not had any initiatives in this area to date. It is a question of having to recycle and go back and have renewed discussion, given the current situation.

So the other thing I am thinking is, the inventory that you have, it was bought at -- if you have 90 days' inventory was bought at a lower price, too, so there is some natural hedge on that. I guess the bottom question I am trying to get to is -- margins will be as they were in the first quarter, as they were in the year, is what you said. It seems to me that we are -- in April we are going to see incremental improvement as you go back and raise prices. So are you just being very conservative on that, thinking that cost escalations could continue, or just what's around that thinking?

There are two things, first of all, remember, just from an accounting standpoint, we use the weighted average cost method. So some of the cost increases are still working their way -- or will work their way through the cost of sales for the balance of the year. And, secondly, our expectation is that costs are going to continue to increase for at least the balance of this year. And that is based on a survey or study of a broad array of the various raw materials that we purchase. Indications are those costs are going to continue.

Okay. So you have not factored in your guidance the fact that steel prices have come down somewhat from their year-end peaks, or something like that?

That's just one element. But the -- as I said, we use a lot of plastic in our containers and petroleum drops one day and spikes back up and those are costs we do not keep much in the way of inventory of containers. So to the extent that those costs increase, it comes through our P & L very quickly.

And your customers, when you approach them, are they -- are they pushing back aggressively, or are they -- or are they in the mode where if you demonstrate that your costs for things like this are up, they are accepting on whatever the pricing lag is?

Nobody likes to take price increases. I think you know that. But let us just say that our customers today are far more understanding than they have been in the past, and that is because the evidence is overwhelming, as opposed to what I call creeping incrementalism.

Okay.

Thanks, Chip.

Thank you.

[OPERATOR INSTRUCTIONS] We will take our next question from Alex Fisinny of LODH.

Yeah, good morning, Alex Fisinny from [inaudible] in Switzerland.

Hello, Alex.

Hello, good morning. I have three questions, the first one is a nice one; I want to congratulate you for your fine fragrances. You have been winning market share very clearly. I was just wondering how you see the market for fine fragrance evolving in the coming years. Will it remain difficult or would you expect a pickup in this market?

As a category, I do not see yet any real indication that the category is growing, although it would be nice if it did, because we are growing, and if we were growing in a growing category our growth would be even greater. I do not anticipate that the progress which we are making in fine fragrance will stop. We've done a very good job and I expect us to be able to continue in that regard.

Okay, thank you. My second question is regarding the -- the profit potential. In addition, I mean, to the increase of prices. Do you -- are you looking at cost-cutting measures or restructuring initiatives that could counter this margin erosion you're seeing such as closing some ingredient sites or acting in some other way?

I think you can safely assume that we're looking at every single element of our business in order to ensure that we restore our margins.

I think in that regard, remember, one of the reasons why margin erosion eroded in the first quarter was that we absorbed additional expenses associated with the closure of Dijon. And I -- there is no debate that the closure of Dijon, while it was painful, was the right decision. So -- and we're going to continue to challenge ourselves in that regard.

Okay, thank you. And the last question is a bit more general. I have the impression that it will be further consolation opportunities in the industry in the coming years; I was just wondering what your view was on this point and your intentions as to a potential participation?

In the past, we have acknowledged that we also believe that there may well be further consolidations within the industry. We will look at any opportunities that present themselves and I would simply repeat what I have said in the past, that before we were to do another acquisition, we would have to believe that there was true strategic benefit for making the acquisition as there was when we made the BBA acquisition. Merely buying turnover, I do not believe would be a strategic benefit that would warrant an acquisition. It would have to go beyond that, but we certainly would take a look at anything that became available.

So you do believe that the pace or the opportunity -- some rather sizeable opportunities could arise in the coming years?

I do believe so, yes.

Okay. Thank you very much.

We'll take a follow-up question from Jeff Zekauskas of J.P. Morgan.

Okay.

Yes, good morning, Silka again. Two more questions.

Can you sort of compare what your selling price increases were compared to your raw-material price increases? And in one of your earlier press releases I think you lay out what the -- what your gross margin -- or, your cost of goods sold in gross margin would have been excluding the fruit business. And so in fact, a margin decline on that basis looks even higher versus their reported results.

You are absolutely right, Silka. And it suggests that we did not do a very good job of achieving price increases relative to our cost increases.

So we're -- so were prices more or less flat or were they up one or just roughly order of magnitude?

I think you have a mix. But suffice to say that we did not perform well with respect to achieving price increases.

Which is why we are --

We are where we are.

And why we are taking what I will call a renewed and stronger effort internally in order to ensure that we can reverse that situation.

So essentially -- so your earnings quote should be just like backend loaded as you get price increases through later in the year?

Well, there are two elements, first of all. Remember, we had a very strong first half of the year last year and a lot of that was driven in North America with restocking and so forth. And so the first half of the year all along we knew that we were not going to have that strong a topline growth. I hesitate to say that the earnings will be backend loaded but obviously the stronger earnings growth -- it is going to take us the full year to get the price increases in place. And the broad range that we provided in terms of earnings per share suggest that we acknowledge that it's going to take some time to achieve that. And, also, some degree of uncertainty over the extent of price increases -- of our costs of -- cost increases for raw materials, excuse me.

And then, lastly, can you give us an update on the progress in your encapsulation technology specifically on your launch of a new detergent or softener products?

Silka, I think we made reference to that a bit earlier in terms of expecting that we would, in the back half of 2005, we would hope that we would have products -- that our customers would have products in the market. And with the pace expected to accelerate in 2006.

Okay. Thank you very much.

So that's -- as Dick mentioned. There's -- the customer decides when they want to launch those and whether they want to launch them as a flanker or whether they want to change the fragrance formulation in the lead brand.

But if -- if all goes well, we expect to see some of the -- some products launched as early as the second half of this year.

Thank you.

I think the other key thing to remind people, is that as we advance new technologies, that does insulate us a little bit more from price pressures from our customers, because this is all patented technology, and I think that while that does not give us pricing any elasticity, it does give us a benefit in that regard. I think we have time for one more question.

We will take our final question, a follow-up from Todd Peters of American Century Investments.

Okay, thanks. Two issues here. You talked about gaining share, is that in the fragrance and flavors and where specifically so you think that is, in the North American area or other parts of the world?

I believe we are gaining market share in fine fragrances; the growth is coming from both the U.S., Europe, Latin America and in -- and in Asia. On the flavors side of the business, we're getting good growth in Latin America, Asia, India. And I would expect that we will continue to get growth disproportionately from the developing countries in the world. And we have said over the past several years now that in terms of strategic opportunities, that the developing countries within the world provide great opportunity, and our emphasis is certainly in that area.

And then, secondly, on your use of cash flow, which is still -- still good going forward here, you do have a share authorization out there. How do you prioritize that, is it debt reduction, share buyback, dividend?

I think it's a combination of all three. And we -- we constantly look at our dividend rate in the context of the guidance which we have provided in the past. We continue to reduce our debt. We do not want and have said that we do not think that zero is the right level of debt but we certainly are in the mode to continue to reduce it a bit further. And share repurchase, we also have continued to -- to utilize to provide shareholder benefit.

Okay. Do you know who you're taking a market share from?

I imagine our competitors.

That --

There are so few of them that are public that on a -- it -- certainly on a quarterly basis it is very difficult to gauge. One of our competitors came out and talked about their sales performance for the first quarter and I think we grew at a slightly higher pace than they did, but that is just -- they are -- and IFF are just two pieces of a very large and fragmented industry.

That is true. Thanks for your time.

Thank you.

: Gentlemen, that does conclude our question-and-answer session. I'll turn the call back to you for closing remarks.

Thanks very much. We will talk to you at the -- the end of the next quarter.

Thanks very much.

Thank you for your participation. This does end our conference. At this time, you may disconnect .